Focus: California; Pension Funds for One-Family Houses

By RICHARD W. STEVENSON

Published: February 23, 1992

LOS ANGELES—
THE recent decision by the California Public Employees Retirement System to invest $375 million in the construction of one-family houses within the state is being welcomed by builders here, who have been squeezed by a severe shortage of financing.

The first large-scale investment by a public pension fund in residential construction is being watched closely by builders across the country, who think it could spur similar moves by public pension funds in other states and open up a potentially huge source of new financing.

Officers of the California retirement system, known as Calpers, said in January that $75 million would be invested with each of three outside investment advisers to provide financing for home builders. Last week, it voted to give an additional $75 million each to two more advisers.

Although details are still being worked out, the advisers will most likely share ownership in new housing projects and help arrange financing packages that would also include bank loans as well as equity investments by the builders themselves.

Builders said the $375 million from Calpers, when combined with the bank financing, could pay for the construction of at least 5,000 homes in California. Because of the recession and the financing squeeze, the number of one-family housing starts in California, the nation's largest housing market, tumbled steadily and drastically from a high of 163,000 in 1989 to 74,000 last year.

Developers say they remain confident that the economy will right itself this year and that California, which has been hit hard by rising unemployment -- its unemployment rate was 8.1 percent in January, one point higher than the national rate -- will resume its course of steady growth

But builders have remained much more troubled by the lack of financing, a result of the failure of many savings and loan institutions and the tighter Federal regulation of banks and savings institutions.

The Calpers investment by itself will not solve the financing crisis, which has made it hard for most builders to get the acquisition, development and construction loans they need for their projects. Most estimates are that the total reduction in available financing amounts to billions of dollars a year within California and tens of billions nationwide.

Public pension funds, which provide retirement benefits for state and local government employees, have invested heavily in commercial real estate and in apartment buildings. But they have never shown much interest in one-family-home projects, in part because of the risks in buying land, improving it, winning all the necessary zoning approvals and then building and selling the homes.

But Calpers officials said they have come to believe that helping to finance new homes in California, especially homes affordable to first-time buyers, is a good investment.

The state's population, which rose 25 percent between 1980 and 1990, continues to grow rapidly -- it is estimated to have passed 30 million now -- and there is an acute shortage of affordable housing. In 1989, 54.6 percent of households in the state owned their own homes, compared with 64 percent nationwide.

Calpers, which has a reputation as an astute investor, believes it can earn as much as 22 percent on its investment. Last month, the pension fund awarded the right to invest the money to three real estate-oriented money-management firms: California Housing Advisors, a venture set up by Montgomery Securities of San Francisco; a unit of Wells Fargo & Company of San Francisco, and the Prudential Realty Group, a subsidiary of the Prudential Insurance Company of America. Last week, it added Alex. Brown Kleinwort Benson of Sacramento and AMB Institutional Realty Advisors of San Francisco to the list.

Those firms will select which projects to back and will arrange financing for each.

Calpers directed that most of the financing go for construction of affordable homes, which builders take to mean houses within reach of first-time buyers. The statewide median price of a one-family home, $198,000, masks significant regional variations, with the low end ranging from under $100,000 in a few areas to more than $300,000 in Los Angeles and San Francisco.

"In looking at the current situation in the housing industry in the state, the consensus seemed to be that there's still good demand out there," said DeWitt Bowman, chief investment officer for Calpers. "The demographics are good and when affordable housing does come on the market, it sells well."

Some investment analysts said Calpers was partially motivated by growing political pressure to use some of its huge investment portfolio to help the state's faltering economy. The analysts said that pension funds in other states may not have the same motivation as Calpers to enter the residential building field, and indeed that pension funds may continue to find the risk of investing in the land acquisition and housing development too high.

STILL, a growing number of pension fund advisers think other funds will follow the lead of Calpers and begin investing in residential housing development projects, becoming major sources of financing along with banks and savings institutions.

"Investment in single-family product will become de rigeur for public pension funds in the 1990's," said a new report from Equitable Real Estate Investment Management of Atlanta.

"The concept that the largest pension fund in California and one of the largest in the country is investing specifically in California is very encouraging," said Robert Rivinius, chief executive of the California Building Industry Association. "Other pension funds will be watching it, and I know they will find the returns to be good and the investments to be safe."

Ultimately, Mr. Rivinius said, pension-fund financing could go a long way toward replacing the old financing from banks and savings institutions.

"We're into a new way of doing business," Mr. Rivinius said. "We've got a new ball game and this is a new ball."

James Z. Pugash, an executive vice president of California Housing Advisors, said he envisions arranging financing packages under which the builder would typically have to put up 10 percent of the total cost as equity. The money management firm, using capital from Calpers, would put up another 20 percent of the cost in equity. The remaining 70 percent would come from banks in the form of loans.

The bank lenders would be paid interest; any profits from the venture would be divided by the builder and the money manager under as-yet undefined terms. Ultimately, the bulk of the profits earned by the money manager would flow to Calpers.

Calpers officials and the money managers said they hope to work out the details and get the program running within a few months.

The new financing cannot come too soon for builders like Bob Ragle of Eagle Ridge Developments in Santa Rosa, Calif.

"Half of the banks I used to use don't exist anymore and the others are extremely cautious," said Mr. Ragle, who because of the financing squeeze is now able to build one new project a year instead of the two or three he used to do. "Any kind of financial help as far as getting subdivision improvements and housing starts going would be an improvement.

"What I'm looking forward to is an additional source of funds that will allow me to get back to a normal situation in my business."